Learn how to calculate retained earnings, understand their importance, and how they impact your business’s financial health and growth potential.
Understanding your company’s financial health starts with more than just profits and expenses, it requires a closer look at retained earnings. This key figure on your balance sheet shows how much profit your business has kept over time to reinvest, rather than pay out to shareholders.
Whether you're planning for growth, evaluating performance, or preparing for funding, knowing how to calculate retained earnings gives you a clearer picture of your long-term financial stability.
In this guide, we’ll break down what retained earnings are, how to calculate them step by step, why they matter, and how they can support smarter financial decisions.
Key Takeaways:
Retained earnings are the portion of a company’s profits that are kept within the business rather than distributed to shareholders as dividends. Over time, they reflect how much profit the company has reinvested to support growth, reduce debt, or build financial stability.
In bookkeeping, retained earnings are tracked on the balance sheet under shareholders' equity. They accumulate across accounting periods and are directly influenced by a company’s net income, net losses, and dividend payments.
These three elements are closely connected. When a business earns a profit (net income), it adds to retained earnings and increases total equity. If it pays dividends or incurs a loss, retained earnings decrease.
Small businesses often maintain retained earnings ranging from $10,000 to $100,000, depending on factors like industry, profitability, and growth stage. For instance, a local bakery might start the year with $10,000 in retained earnings, earn a net profit of $30,000, and distribute $5,000 as dividends, resulting in year-end retained earnings of $35,000.
Understanding retained earnings helps businesses evaluate their financial performance over time and make informed decisions about reinvestment, expansion, or payouts. It’s a key indicator of how well a company is managing its profits to support long-term growth.
Distinguishing between retained earnings and net income is essential for interpreting your business’s financial health from an accounting perspective. Though both figures play a critical role in financial analysis, they serve distinct purposes.
Net income refers to the total profit or loss a company generates during a specific period. It reflects the company’s ability to generate profit by subtracting expenses (like operating costs, taxes, and interest) from total revenue. This figure is found on your income statement and provides a snapshot of your business's financial performance within that period.
In contrast, retained earnings represent the cumulative amount of profit that has been kept in the business, rather than paid out as dividends. This figure reflects the company’s overall financial health over time, showing how profits are reinvested in the business for growth, debt repayment, or other strategic purposes. Retained earnings are found on the balance sheet under shareholders' equity.
In short, net income measures short-term performance, while retained earnings offer a long-term view of financial health. Both are crucial for understanding your company's overall success and planning for its future.
Retained earnings aren’t just a reflection of past profits, they’re a powerful tool for shaping your company’s future. While net income shows short-term performance, retained earnings show how well your business has managed and reinvested those profits over time.
One of the biggest advantages of retained earnings is that they allow your business to grow without relying on external funding. Instead of taking on debt or giving up equity, you can use retained profits to:
Because retained earnings link your income statement and balance sheet, they also help track how profit is being converted into long-term value. This makes them a key indicator for strategic planning, not just financial reporting.
For potential investors, lenders, and stakeholders, steady growth in retained earnings can be a sign of a well-managed, financially sound company. It suggests your business is not only profitable but also disciplined in how it reinvests and sustains that profit across the accounting cycle.
Calculating retained earnings is a straightforward process that provides key insight into how much profit your business has reinvested over time. The formula is:
Retained Earnings = Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends Paid
Each time you close an accounting period, this formula helps update your retained earnings total, which in turn reflects how much profit remains in the business for future use.
Regularly calculating retained earnings gives you a better handle on your company’s financial trajectory and supports smarter decisions around reinvestment, growth, and managing equity.
It’s simpler to grasp your business’s retained earnings when you take it one step at a time. We'll walk you through the full process, from gathering the right data to interpreting the final result, so you can confidently calculate retained earnings and better understand your company’s financial position.
Start by collecting the three essential numbers you’ll need:
Ensure your data is accurate and up to date—even small errors in these figures can affect your final calculation.
Net income is your business’s total profit after subtracting all expenses from total revenue. If expenses exceed revenue, you’ll have a net loss instead.
Example:
If your revenue is $100,000 and expenses are $80,000, your net income is $20,000.
If expenses are $105,000, then you’re working with a net loss of $5,000.
This figure plays a key role in updating your retained earnings.
Dividends are the portion of profits distributed to shareholders. If your business issued dividends during the period, subtract that amount from your calculation.
You can find dividend payments in:
If no dividends were paid, just use zero for this part of the formula.
Now plug your numbers into the formula:
Retained Earnings = Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends Paid
Example:
Calculation: $50,000 + $20,000 – $5,000 = $65,000 retained earnings
This figure becomes your ending retained earnings, which will carry over to the next accounting period as the new beginning balance.
Once you’ve calculated your retained earnings, take a moment to interpret what the number tells you.
Use this insight to guide future decisions about reinvestment, dividends, or cost management.
Accurate retained earnings are essential for reliable financial reporting and smart business planning. Yet, many businesses make simple but costly mistakes during the calculation process. Here are some of the most common issues and how to fix them.
Even high retained earnings aren’t always a good thing. If your business is consistently holding onto profits without reinvesting, it may signal missed growth opportunities. Use retained earnings strategically, not just to stockpile cash.
Retained earnings play a central role in your company’s financial reporting. They’re more than just a line item — they connect the income statement to the balance sheet and reflect your business’s long-term financial strategy.
On the balance sheet, retained earnings appear under the equity section. This figure shows the cumulative profits your business has held onto instead of distributing as dividends. As retained earnings grow, so does your company’s overall equity, which can indicate strong financial health and long-term profitability.
Businesses with high retained earnings often have stronger balance sheets. Inadequate cash flow management, including insufficient retained earnings, causes 82% of business failures.
Higher retained earnings often signal that a business is reinvesting in itself, using profits to fund operations, pay down debt, or support future growth. Nearly 60% of small businesses use retained earnings as a primary source of funding, rather than external loans or investor capital.
Retained earnings are directly influenced by your net income or net loss, which is reported on the income statement. At the end of each accounting period:
Small businesses, on average, reinvest 50–90% of their net profits back into operations, highlighting the importance of understanding how net income directly fuels retained earnings.
This link between net income and retained earnings shows how each period’s performance affects your long-term financial position.
Accurate reporting of retained earnings is critical for producing reliable financial statements. Lenders, investors, and business owners rely on this number to assess:
Understanding how retained earnings affect your financial statements gives you a clearer picture of your company’s value and helps guide smarter financial decisions.
Now that you understand how to calculate retained earnings, you're better equipped to manage your business’s finances. This knowledge enables you to make informed decisions on investments, dividends, and growth strategies, which are critical for sustainable success.
However, mastering retained earnings is just one piece of the puzzle. To fully optimize your financial operations, especially when it comes to managing your invoicing and payments, having the right tools is essential. That’s where Tofu can help.
With our mobile invoicing app, you can:
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Retained earnings are profits kept by a company after paying dividends to shareholders. They are a key part of a company's retained earnings and represent the accumulated profits over time. These earnings are often used for future business activities, such as reinvestment in growth, paying off debt, or funding new projects. The amount of retained earnings can be found in the retained earnings account, which is part of the section of the balance sheet under equity.
Yes, retained earnings may be negative if a company has incurred losses over time or paid out more dividends than it earned. In this case, the balance in the retained earnings account would show a deficit, reflecting that the company’s profits have been exhausted or surpassed by losses and dividends.
While retained earnings provide insight into a company’s profitability and how much profit has been reinvested, they don’t account for the company’s current cash position. As an accounting entry for accumulated profits, they don’t reflect net earnings or cash flow directly. It’s important to look at other financial indicators to get a full picture of a company’s financial health.
Retained earnings can be used for a variety of purposes, including funding business expansion, paying off debt, or reinvesting in new opportunities. These earnings are essential for a company to grow without relying on external financing. For example, a company may choose to subtract any dividend payments from its retained earnings to preserve more capital for reinvestment.
A high retained earnings balance typically indicates that a company has been profitable and has reinvested its profits instead of distributing them to shareholders as cash dividends. This suggests the company is focused on growth and financial stability. It’s a sign that the company has been successful in retaining earnings and putting them to work, which may signal strong future performance.